The Trade Deficits are Falling!

Okay. So it isn't really big news, especially compared to other recent events. Moreover, the Trade Deficit didn't just fall, it improved!

Not exactly earth shattering stuff, but the trade deficit is typically a hot button issue when the elections roll around. Like the Federal Reserve Funds Rate, not many people really understand exactly what it means. The better term is Current Account Balance. This number tells us who owes who money after exports and imports are tallied up. Currently, the US holds a very large imbalance of payments with China and pretty much the rest of the world. Logistically, this is only an accounting term because, in actuality, China and the rest of the world have been paid, they've just chosen to deposit the money in a US bank rather than exchange it for their currency or buy US goods. The trade deficit, therefore, is not a debt. As Milton Friedman has pointed out, if you include banking services (as an econogineer would argue since goods and services are only different forms of labor), there is no such thing as a trade deficit. Our import partners have merely chosen to purchase interest bearing bank accounts. This shouldn't strike anyone as odd since we offer very good and honest banking services, something not present in many foreign markets. If you had a business in Russia, where would you want your money? In a Russian bank under the greedy eyes of the Kremlin or the US? We offer lots of financial services and security for which we charge a premimum.

Still, the Trade Deficit raises much consternation from many circles, especially those with a protectionist agenda. Accusations of "dumping" are routine when some manufacturing sector feels it is subject to unfair trade practices. This, however, cannot be argued to be beneficial for the entire United States. In fact, what benefit has the US gained by protecting the car industry? It saved jobs for people in that industry at the cost of everyone having to pay many thousands more for their cars. In politics, it's concentrate the gain, spread the pain (but the total pain is almost always more than the total gain).

This has led some to propose absurd arguments to support their negative opinions about the Trade Deficit being the ruin of us all. In this story, the author proposes that there is a correlation between US debt and the Trade Deficit when it is obvious his graph shows the opposite. What's more interesting is that from my own analysis using Bureau of Economic Analysis data, it's easy to show that growth in Gross Domestic Product has a higher correlation with Imports (correlation coefficent of 0.77) than with exports (coeff. of 0.33). In fact, during periods of expansion, that correlation increases for imports and decreases for exports! This shouldn't surprise anyone because when we are expanding, we're even more attractive for investment. All that money lowers our lending rates through supply and demand. Who cares who you pay the interest if that interest is lower? Even with an unusally weak dollar, the Chinese and many others still would rather keep their money here. Mortgage rates are lower now than back in the early 90s when the trade deficit growth was zero. Or how about in the 70s when we had a trade surplus but mortgage rates were over 15%?

Most importantly, we need to remember that the trade deficit is expressed in dollars. In terms of physical goods, we hold a surplus. Although the new Ben Franklins are pretty, I'd much rather look at an HDTV.

Strategically, we should also be happy to hold large balances of the world's money. It makes them less likely to do something to cause us to confiscate those billions. They are, in the world of international politics, bargaining chips.

In the end, we all win though I think the Chinese people in a free system might want to enjoy a better standard of living instead of helping us improve ours. This is the major negative. The econogineer hates government manipulated markets and exchange rates. The Chinese fix their exchange rate artifically low to encourage export. We are certainly making out in this deal but it's creating a false sense of luxury in us at the expense of the Chinese people and perhaps our own and other foreign manufacturers. On the whole, though, we benefit greatly from this exchange.